Insurance · 24 September 2018

An ex-employee opened a rival business – is a restrictive covenant worth enforcing?

In any legal dispute, emotions will be running high but the law isn’t very good at compensating hurt feelings

If a restrictive covenant is breached, is it always worth enforcing it? Grid Law founder David Walker helps one business owner understand their options after an ex-staff member set up a rival company nearby, contravening their employment contract.

Question

Is it worth pursuing an employee and enforcing their restrictive covenants against them?

Their employment contract says that they must not work in a similar business within a four-mile radius within a year of leaving. However, within two months of leaving they are setting up their own business in competition to me and are based only a mile away.

Answer

Thanks for your question.

When faced with any legal dispute, clients often ask “Is it worth pursuing a claim?

This is such a difficult question to answer and the best I can do is help them look at the situation objectively and assist them in coming to their own decision.

In any legal dispute, emotions will be running high but the law isn’t very good at compensating hurt feelings. You need to put your emotions aside (as hard as that may be) and make a rational decision based on the facts and your best assessment of the real damage being done (or is likely to be done) to your business.

Do you have the right to bring a claim?

This is the first question to answer and means showing that the restrictive covenant is enforceable and the employee has breached it.

To be enforceable a restrictive covenant must:

  1. Protect a legitimate business interest (for example your relationship with your customers or suppliers, or any trade secrets you have)
  2. Be reasonable and no wider than is necessary to protect that interest
  3. Not be contrary to public policy (for example, they shouldn’t be used to stop employees from changing jobs)

When assessing the reasonableness of a restrictive covenant in an employment contract the courts are likely to take a strict view of these criteria. This because of the inequality in bargaining power between the employer and employee compared to in other business to business relationships.

Next, you need to show that the employee has either breached their restrictive covenant or is about to. Normally, this would be relatively straightforward as they would start working with a competitor business, or they may have handed in their notice and told you of their intention to do so.

If the employee is starting their own business, this may not be a breach of the restrictive covenant if the clause only forbids them from working for a competitor.

If starting their own business is covered, it may still be more difficult to show that it’s reasonable to enforce the restrictive covenant against them.

If you’re well established in your industry and have a strong reputation, customers may be reluctant to switch their loyalty to your employee’s startup. If your employee isn’t a genuine threat to your business it may be unreasonable to enforce your restrictive covenant against them.

What are you trying to achieve by enforcing the restrictive covenant?

Assuming you have the right to bring a claim, you need to be clear about what you’re trying to achieve. Remember, your priority is to protect your business, not to punish your employee.

Basically, you have two real options. You can apply for an injunction or seek damages/compensation.

Applying for an injunction

An injunction is a court order forbidding someone from carrying out a particular act. So, in your case, you would be asking the court to grant an injunction that forbids the employee from working for a competitor or starting their own business. If the employee carried on and did this after the order was given, they would be committing a criminal offence and the penalties could be harsh.

Obtaining an injunction isn’t easy and it’s not appropriate in all cases.

To obtain an injunction (even if on a temporary basis) you would need to show the court that:

  1. There is a serious issue to be tried. This means your claim has real substance to it and it’s not just a frivolous or vexatious claim.
  2. Damages wouldn’t be an adequate remedy. For example, you would need to show your business is likely to suffer irreparable damage by the employee revealing a trade secret or attempting to steal your complete customer database; and
  3. On the balance of convenience an injunction should be granted. To decide this, the court will decide which party is likely to suffer the most harm by either granting or not granting the injunction.

Injunctions are a discretionary remedy so the court may not grant one, even if these conditions have been fulfilled. For example, if there’s been a dispute between the employer and employee which contributed to the employee leaving and there’s been questionable conduct on the part of the employer, the court will probably exercise its discretion and not grant the injunction.

When a court grants an injunction, it usually does so on a temporary basis, pending a full trial, and only after hearing limited evidence (possibly only from the employer). This means there’s a greater risk that the court will make the wrong decision and grant the injunction when it wouldn’t have done if it had all the facts.

To guard against this risk, the court will usually require the employer to give a cross-undertaking in damages. This means that the employer promises to pay the employee compensation in the event that the court was wrong to grant the injunction. If the employer can’t afford to give this cross-undertaking, the injunction is unlikely to be granted.

If you’re going to apply for an injunction, you must do so quickly. Any delay could jeopardise your chances of getting one.

Claiming damages or compensation

If you’re unable to obtain an injunction or you decide not to apply for one, you may seek damages or compensation from the employee.

To claim damages, you have to start legal proceedings and show that you have suffered a loss as a result of the employee starting work for a competitor or starting their own business in breach of their restrictive covenant.

If you can prove this, the court will assess the amount of damages you should receive based on the evidence you put forward.

Claims against the new employer

I know that this isn’t relevant to you now, but if the employee’s business doesn’t work out and they seek new employment, you may have a claim against their new employer.

To bring a claim against the new employer you would need to show that they induced or conspired with the employee to leave you and join them in breach of their restrictive covenant.

Alternatively, you may be able to claim against the new employer if you can show that they have received your confidential information in breach of the employee’s contract.

Evidence is always difficult to obtain in these circumstances but if you can bring or just threaten to bring a claim against the employee’s new employer it’s a good way to put pressure on them.

If you’re serious about legal action this may also be a better option than suing the employee direct as in most cases, the new employer will have better resources to settle any claim than the employee.

This brings us on to the final point when deciding whether to enforce a restrictive covenant or not.

Is a claim financially viable?

Even if you have the right to bring a claim and you have a good chance of enforcing your restrictive covenant, you still need to decide whether, financially, legal action is worth pursuing.

To determine this, ask yourself: “What is my loss here and what damage is being done (or is likely to be done) to my business?”

If you’re a company director, it’s even more important to ask this question because your decisions should be made in the best interests of the company. You shouldn’t pursue a claim just to make yourself feel better about the employee leaving.

Assessing lost profits from any customers your employee takes should be relatively straightforward, but putting a specific value on losing a trade secret may be more difficult.

However, you must do your best to put an approximate value of the likely damage to your business. If you really can’t put a figure on it, how are you going to explain your loss to the court? If you can’t show any loss, you’re unlikely to be awarded more than very nominal damages.

When you have an approximate value for the damage to your business, you can balance this against the costs you will spend on pursuing the claim.

Without knowing far more details about your situation it’s impossible to say what these might be but even with the smallest of claims, there’s always a risk that your legal fees will run to several thousand pounds. For larger, more complex claims, legal fees can easily reach tens of thousands of pounds.

There are two important points to keep in mind here:

  1. If the damage to your business, and so the value of your claim, is less than the small claims limit of £10,000 you’re unlikely to recover any of your legal fees, even if you win
  2. If your claim is worth more than £10,000 and you lose you could have to pay your employee’s costs of defending the claim (as well as your own)

Also, don’t underestimate the amount of management time that dealing with this matter will incur.

The final consideration, assuming you will win and on paper, the claim is financially worth pursuing, is whether your employee has the ability to pay any damages (and costs) awarded to you.

If they don’t, this could be an expensive exercise with no real benefit to you, unless of course, you’re satisfied that enforcement of the restrictive covenant is a worthwhile exercise in itself.

Hopefully you’re now be in a better position to decide whether or not to bring a claim to enforce the restrictive covenant. Even if you decide not to take legal action, you can still threaten it and you may be able to reach a negotiated settlement which gives you some more security and helps protect your business.

If you would like any further advice on this issue, please feel free to email me again at editors@businessadvice.co.uk.

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ABOUT THE EXPERT

David Walker is the founder of Grid Law, a firm which first targeted the motorsport industry – advising on sponsorship deals, new contracts and building of personal brands. He has now expanded his remit to include entrepreneurs, aiding with contract law, dispute resolution and protecting and defending intellectual property rights.

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